Homeowner Insurance Guide For BeginnersHomeowner Insurance Guide for Beginners

The policy of choice for those who own homes is the Homeowners Insurance Policy.  In this Homeowner Insurance Guide for Beginners we must distinguish, however, between owner occupied homes and those occupied by tenants and occupants other than the owner of the property.  When the home is not owner occupied the appropriate form of coverage is a dwelling owner policy or a landlord policy.  I cover information for landlord policies and dwelling owner policies in a separate place on this website but it is generally true that much of the descriptions for the coverage of a homeowner policy will apply to some of the coverage in dwelling owner policies.  There are important differences so they are handled separately.  Another point that should be explained here is that a tenant living in a rented house buys a form of homeowner coverage called the Tenant Policy.  A Tenant Policy is not sold to owners of rented dwellings.  A Tenant Policy is also referred to as an HO-4 policy.  When you see the coverage described as a “Tenant Policy” it is referring to a non-owner occupant of a rental structure, whether a single family dwelling or an apartment building, and even though the tenant does not “own” the building, we provide coverage for tenants under homeowner policies as HO-4 coverage.

At the start of the Homeowner Insurance Guide for Beginners, you should know that there used to be seven different homeowner policy forms (forms of coverage) in common use at one time.  They were described as HO-1, HO-2, HO-3, HO-4, HO-5, HO-6 and HO-8 type policies.  I will briefly describe each.  The HO-1 Basic homeowner policy is no longer generally available.  Before I start that task I also want to refer to the basics of constructing property coverage for a homeowner form,  First there is the types of property we basically include coverage for in every form of the homeowner policy.  Secondly, we should understand the types of perils or causes of loss that are provided by each policy type.  We should also understand the basic structure of the policy that is true for homeowner policies and how we value property at the time of loss.

Basic Policy Construction and Coverage Format
The homeowner policy has a similar structure regardless of whether or not it is a HO-2 or an HO-8.  The HO-4 Tenant Homeowner and HO-6 Condo Owner policy forms do have notable exceptions and I will cover their differences here.  The following basic policy format exists for all owner occupied policies:

Section 1 – Property Coverages

Coverage A – Dwelling at 100% of Replacement Cost
Coverage B – Other Structures – Coverage is 10% of Coverage “A “Automatically
Coverage C – Personal Property – Automatic Coverage is 50% or 55% of Coverage “A” Amount
Coverage D – Loss of Use – Varies from 20% to the Actual Loss Sustained for 12 months after a loss

Section 2 – Liability Coverages

Coverage E – Personal Liability – Minimum of $100,000 up to $1,000,000 depending on carrier
Coverage F – Guest Medical Payments – Minimum of $1,000 up to $10,000 depending upon the carrier

Types of Perils (also known as Causes of Loss) Included in Homeowner Policies

A peril is a cause of loss to property.  There are basically two types of construction as it relates to the perils included in a policy.  One is referred to as “named peril” policies.  These types of policies list every peril (cause of loss) that is included and they do this for the dwelling property and separately for the personal property (contents) in a policy.  When the policy names the perils we refer to the policy coverage as BROADFORM coverage.  When HO-1 policies were available these were the most basic form of named peril policies.  Broadform means that the basic name peril coverage is broadened to include coverage for losses that were not included in the basic perils or have had definitions of perils broadened to include new causes of loss.  For example, damage by vehicles is broadened in the HO-2 policy to include damage by vehicles you actually are operating.  Theft is added to broadform policies that is not included in basic policy forms.  HO-2 and HO-4 are broadform only policies.

The second basic type of coverage construction is centered around the idea of “all-risks” of loss to property.  That is not a very accurate description but is often used less than carefully.  What is meant by “all risk” coverage is all accidental direct physical loss (ADPL) except those losses that are otherwise limited or excluded in the policy language.  We refer to these forms of coverage as “Special Form” policies.  As limiting as the description may appear at first, there is one huge difference between Broadform and Special Form coverage formats.  In a Broadform policy, if the loss is not directly attributable to the cause of loss written and listed in the policy, there is not likely any coverage.  This means if it isn’t listed in the policy, it isn’t covered.  On a Special form policy we tend to look at the cause of losses differently.  Because we grant coverage for all “accidental direct physical loss” to your property, it is covered unless limited or excluded elsewhere in the policy.  This is a huge difference and it removes the burden of proof to a large extent from having to show a loss to your property was caused by some cause of loss in the policy language.  There are types of losses excluded in both Broadform and Special Form policies but because of the much broader number of potential losses under Special Form coverage, the list of exclusions is broader and more precise than the Broadform policy language.  The HO-5 is truly special form coverage on both the dwelling and the personal property.  Some companies accomplish the Special Form coverage on policies by adding an endorsement to an HO-3 policy to change the personal property coverage to special form coverage.

The HO-3 policy type is the most commonly issued policy for owner occupied homes.  The coverage on an HO-3 homeowner policy is Special Form for the building structures, and Broadform on the personal property.   An HO-8 policy also is constructed like an HO-3 policy but has other important differences regarding settlement and valuation methods built into the policy that make it a separate type of policy.  I’ll cover this policy type separately.  The HO-4 Tenant policy includes Broadform coverage on the contents, just like the HO-3 form, because there is no coverage under a HO-4 Tenant policy for the structures occupied since they are owned by others.  An HO-6 Condo Owner policy can be issued to be just like the HO-3 or endorsed to be like the HO-5 policy form of coverage.  An HO-6 Condo Owner policy isn’t often expected to cover the structure completely since it is jointly owned by the owner community.  However, bylaws and owner covenants may require – and common sense dictates – certain improvements and betterments to the standard condo unit build out (sometimes referred to as the “fit and finish”) be covered by the unit owner.  This refers to the inside of the unit under the owner’s ole control and influence when the individual may appoint his unit differently than the neighbor unit.  It is hard to judge exactly what amount of coverage is needed to replace and build out the inside portion not covered by the Condo Association but the Coverage “A” should be included on most HO-6 Condo Owner policies purchased.

Valuation of Loss, Loss Settlement Methods, and Insurance to Value

Since 2008 a vigorous debate has opened up about the apparent discrepancy between the valuation insurance companies use to provide insurance coverage for your dwelling and the valuation your local tax department has affixed to your property.  While confusing, the two different valuation methods in use shouldn’t be confusing.  Your property taxes are based upon the approximate market value of your home as judged by the property tax agency in your area.  Your taxes are based upon that calculation or a portion of that calculation (in areas where an “equalized” valuation method is in use).  Insurance IS NOT issued on the basis of “market value”.  We use two other method of valuation:  1)  Replacement Cost, and 2)  Actual Cash Value.  Let’s explain.

Insurance companies cannot rely upon the fluctuations in market value to assure that we can repair or replace the dwelling structure.  That is why we rely only upon the replacement cost calculations to set the coverage “A” amount.  Unlike finding a used automobile, which is rather easy, we don’t have an effective marketplace to buy used carpet, used lumber, plywood, drywall, wiring, etc, to replace your home.  You wouldn’t want used carpet either!  That is why the only fair method for your insurance company and you to set the amount of coverage is based upon the replacement cost of the materials used to fabricate and construct your home.  When you choose to have your home repaired, or when reconstruction is required due to the scale of the loss, we will have enough insurance to buy new lumber, plywood, carpet, cabinets, wiring, and the other materials that go into making your home.

If you don’t rebuild, if you don’t repair your home, then all we owe you is the “actual cash value” of your loss.  Actual Cash Value (ACV) is the depreciated value of the home or damage based upon its diminished useful life.  ACV then is the value of your home on a depreciated basis and we always begin calculating the ACV from the Replacement cost.  The reason we won’t pay you the limit on your policy when you don’t choose to repair or rebuild is because that would give you the incentive to damage your own property.  One of the principles that support insurance as an effective method of transferring the risk of loss is the “principle of indemnity.”  The “Principle of Indemnity” essentially means that we return you to the point of beginning, the point just before the loss happening, with neither a loss or a gain.  To pay you policy limits without the requirement that you rebuild would be a reward that violates the principles of indemnity and subject insurance to fraud and abuse.  In insurance, there can only be a return to the point just before a loss without the chance of rewarding you for having had a loss

As for your personal property, coverage “B” on your declaration page, replacement cost is an added coverage and needs to be specifically purchased to provide protection to your personal property.  Replacement cost coverage on your personal property means that after a loss you will have be protected from the depreciation of a lost piece of personal property as long as you replace the item.  As with the dwelling terms, if you don’t replace an item, you will receive only the depreciated value for an item or items after a loss.  There is a third method of valuation used to set the insurance amount.  That is found only on an HO-8 home policy type.  The HO-8 basis of valuation used to set the insurance amount is the “market value” of a home as if the loss occurred on the day before a loss.  Most owner occupied properties will probably find other homeowner forms a better match for insuring their property.  However, in some instances the HO-8 policy form makes sense.  One example is when the property is very old and it would never be reconstructed using the same methods of construction, materials and techniques used when it was originally built.  For example, we use plywood and OSB sheet goods to deck a roof or floor.  It was more likely 100 years ago that thick dimensional planks were used that just can’t be affordably acquired today.  Another place a change makes sense in the wall surfacing material.  Drywall material is ubiquitous and makes for more sense to use than plaster and horse hair and lathe common 100 years ago.  The HO-8 policy is not widely available but is still in use by some companies.

There is one other area of concern as it pertains to Valuation of Loss, Loss Settlement Methods, and Insurance to Value.  Proper insurance amounts are not an exact science.  It is best to have more insurance than needed, within reason, than too little insurance.  The tools in use by companies today are reasonably good at helping establish the value to set insurance amounts.  The values they determine are often the minimum required insurance amounts to be properly protected by the policy.  Ohio is one of the states with a A”valued policy law” on the books.  In its strictest form a “valued policy law” requires the insurance company to pay the limit of insurance on a dwelling considered to be a total loss.  In 1980 Ohio amended the law and added a provision exempting policies offering “replacement cost” building insurance from the requirement to pay the limit of insurance whether or not a person rebuilds their home.  That is one reason I suspect that the HO-8 market value policy is not used more commonly than it is.  The original intent of the “valued policy laws” were to protect the insured from after-the-fact bickering over buildings being over-insured and companies wanting to pay less that the amount of coverage purchased.  Using replacement cost in the policy protects the insured from losing their homes and also protects carriers from rewarding customers for having a loss and walking away from their dwelling.


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